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The FSA announced today that they want to clamp down on short selling of companies in the middle of rights issues.

Short selling is when you sell something (normally a share) you don’t own… in the expectation that the price is about to fall, and you’ll be able to buy it back quickly enough to make a profit.

There are various ways to carry out this trick – but the one the FSA are particularly concerned with is where the person doing this borrows the share from someone else (for a short period, for a fee, of course.)

The more people who want a share to fall, of course (and anyone who’s shorted has a vested interest in seeing a fall), the more likely falls are. The key question is whether this is overall a good thing or a bad thing. In the past people like Jim Rogers have (from memory, since I don’t have the book in front of me, but I’m 99% sure it is him I’m thinking of) written in defense of the practice, not on the basis of personal ability to make money, but in terms of how it overall helps economies!

On today’s move, the various commentators have jumped onto this with different approaches:

Robert Peston (at the BBC) has blasted short-selling in the past, and applauds the FSA’s move.

Chris Dillow (who writes for Investors Chronicle, but has posted on his personal blog) is pro short-selling.

In the past, I’ve been very much a Peston fan (I think his coverage of the Northern Rock debacle was second to none), but in this case, I’m firmly with Chris Dillow.

Peston’s argument is actually aimed at the people who LEND the shares, enabling the shorting. He claims it’s “short-termist and thick” (because it causes shares to fall in value, and thus harms the institutions doing the lending). I disagree – the lenders know this, but it’s more than counter-balanced overall (in their experience and opinion) by the fees they get from doing the lending! (Win some, lose some, end up ahead, rather than win every one, of course.)

Chris Dillow’s article outlines the case for promoting short selling very well, so I’ll not even try to re-run the issues here… however, taking a step back, I wonder whether the FSA mightn’t be onto a good thing.

The FSA aren’t saying that people can’t short, though… They are saying that anyone who shorts a material number of shares (more than 0.25% of any company) should have to make a public declaration of this position.

In the past, I’ve spoken out in favour of transparency, liquidity, and fungibility… shorting doesn’t affect fungibility, and improves liquidity… so adding transparency to the shorting process is something I’d approve of.

Unlike the FSA, however, I don’t want to “clamp down” on shorting… just bring it into the light a bit more.